Transcript: WSJ Tech Live conversation with Mary C. Daly and Nick Timiraos

Nick Timiraos:

Well, Mary, thank you for joining us here today.

Mary C. Daly:

I’m delighted, and it’s good to see everybody in the audience. Thank you for having me.

Nick Timiraos:

And welcome to our live audience following on Twitter. Mary, I want to quickly set the scene here on the economy. If we go back in time 18 months, we had inflation around 4% and a lot of worry that it would get stuck in the threes, which, if you’re a central bank targeting 2% inflation, that is not good. We had a tight labor market with the unemployment rate at three and a half percent. And the Fed hiked short term interest rates above 5% and then held them there. Now, fast forward to today. Inflation has continued to come down. The unemployment rate has crept up. It now sits just above 4%. As Kim said, you cut interest rates last month by 50 basis points. Was this a one and done, and rates are now in the right place, or do you think interest rates are still restrictive and could that warrant more cuts in the months ahead?

Mary C. Daly:

Sure. And I will be speaking for myself today, but as the chair said in his press conference, and as the statement has indicated, you know, we will continue to adjust policy to make sure it fits the economy that we have and the one that’s evolving. And as you said, we’ve made a lot of progress towards our goals – 2% inflation and doing that as gently as we can without injuring the labor market or the broader economy. So far, that’s happening well. And the 50-basis-point cut that we took was meant to rightsize policy, to recalibrate it so that it’s in line with what we have. Looking ahead, I expect additional cuts going forward to continue as inflation comes down, to continue to ensure that we do two things simultaneously: get inflation to 2% and create the conditions for a durable expansion. That is my definition of a soft landing, a durable expansion that continues to grow jobs and businesses and delivers 2% inflation.

Nick Timiraos:

So the interest rate cut last month was the first one of this cycle since you raised interest rates above 5%. And there was a debate about whether to do a smaller quarter point cut or a larger half point cut. Obviously, you and your colleagues approved the larger one. Was that a close call in your view?

Mary C. Daly:

You know, I think it is a close call. Anytime you’re recalibrating policy, it is a close call, and you should expect that. If it’s not, then something else is happening. But this was really a call that I came down strongly on 50 after, you know, deliberating with myself and my colleagues and others is that, you know, ultimately we had been very patient and I think that was appropriate to ensure that we were really on a path that we believed was sustainable towards 2%.That was that we wanted – to have more confidence. I also wanted to myself see that the labor market had really downshifted to something more sustainable. That demand and supply were now in balance. That was done. I had more confidence in both of those. And then the 50-basis-point adjustment was what’s needed to, when that patience is over and we have more confidence, get policy rightsized. I didn’t want to find myself in a world where we had failed to do the rightsizing and then only to find out that we had overtightened and caused a problem – taking jobs from people, giving them low inflation but taking jobs. That’s actually not the definition of a soft landing, nor is it the definition of our congressionally mandated goals.

Nick Timiraos:

So the Fed has another meeting in two weeks. Will you support another interest rate cut at that meeting?

Mary C. Daly:

You know, I’m going to say what I always say in times prior to this meeting is that I’m data dependent, so I’ll keep getting the information. I think it’s a good time to remind people what data dependence means. It does not mean data reactive. So it’s not a particular data point that changes my mind. That would be reactive. It’s data coming in [that] informs the forecast or the projection for the economy as I see it. So far, I haven’t seen any information that would suggest we wouldn’t continue to reduce the interest rate consistent with achieving that durable expansion with price stability, 2%. And you asked the question right at the beginning, is policy still tight? And in my judgment, it absolutely is. If you looked at the real rate of interest against historical heights, this is a very tight interest rate for an economy that already is on a path to 2% inflation, and as I don’t want to see the labor market slow further.

Nick Timiraos:

So you mentioned that it’s important not to be overly reactive and that you think rates are restrictive. I just want to get, you know, if you look at the economy recently, job growth looked like it was slowing down. This summer, the unemployment rate hit 4.3% in July. And a lot of folks said, “Uh-oh, historically, when that number starts to go up by a little bit, it goes up by a lot.” Companies let workers go. It’s like, you know, holding a beach ball underwater. Let it go up a little bit and it pops up. Then this month we got news that job growth was better than initially reported. This summer the jobless rate actually went back down close to 4%. And so some people look at that and they say, well, maybe you didn’t, maybe you didn’t need to do this. Maybe you can just kind of hold the horses here on interest rate cuts. It sounds like you don’t agree, you know?

Mary C. Daly:

Well, I think the jobs market data being revised and going back and forth is just a good lesson of why you can’t be data-point dependent. You know, if you run a business, I’m positive this is true. You do not look at one indicator and say you understand your business. You’re looking at a full range of indicators to get a sense of how things are going.

And the Fed is the same way. We look at a variety of indicators, and not just the ones in the published data. Those data are by their nature, backward looking. We need to look forward. So I spend a lot of time coming to events like this, talking to contacts across the Twelfth District and the entire country, everything from a small business all the way up to global businesses, asking simple questions. Have you slowed your hiring? And the answer is yes. Have you started to move your layoff plans to your desk and talk about them in your board meetings? Or are you still managing your headcount through attrition? And what I hear is, still managing headcount through attrition. You want to reduce it, you just don’t refill. Not really moving any layoff plans to the desk. Now, tech is a different story. There were some tech layoffs, but that I, my own judgment, you guys can tell me if I’m wrong, is that was for a different reason than the economy is slowing to a place where firms would layoff, and we’re certainly not hearing that elsewhere. So those pieces of information are, what inform my sense that my assessment that inflation is continuing to come down. We don’t hear a lot about pass through. Consumers are trading down, and we don’t see firms falling off a cliff and saying the economy is terrible. But I also don’t see them robustly going out and increasing their hiring plans. They’re really steady in the boat, cautiously optimistic. And to get this soft landing accomplished and to have a durable expansion, we have to adjust the policy rate as inflation falls.

Nick Timiraos:

So what are you hearing from companies right now, Mary, about pricing power? Because a couple of years ago, it seemed like everybody, demand was strong, and you could push price increases. You could use price as a lever to keep revenues and margins where you wanted them. Has that changed?

Mary C. Daly:

It has changed. And, you know, we do a survey at the San Francisco Fed and have done it for over a year. But in other, we do it across the country as well, other reserve banks. And what you hear again and again and again is that those glory days, as some firms would call them, of being able to just pass things through – and remember, many firms were also struggling with input cost increases and just passing through to survive, really. But others were using that pricing power opportunity. At this point, those days are over. I mean, when consumers start trading down, and they used to buy this, and now they’re buying something that’s lower cost, but trying to get the same service, then you know, your pricing power is limited. Consumers are in inflation discipline. Consumers are the best allegiance to the Fed because once they are picky about what they’ll pay, that keeps inflation coming down. And that certainly is something that we’ve seen. It’s something I want to continue to see, but it’s something we have seen.

Nick Timiraos:

So I’ve focused a little bit on the tactics of how you get interest rates down, but I think what a lot of people really want to know is, where are you headed? What is the final destination? And you don’t always know this when you’re doing it, but central bankers often refer to this unobservable, neutral, or normal level of interest rates when the economy’s at equilibrium. So five years ago, people thought that might be around two and a half percent nominal interest rate. Could that new normal be higher, something in the fours? Or do we end up with interest rates settling out closer to where they were before the pandemic?

Mary C. Daly:

You saw my expression when you said over four. I mean, I think ultimately a reasonable estimate, in my judgment. Now there’s a range of estimates, and everybody has a different model and a different estimate of, because it is hard to measure, and it’s certainly not known. It’s not a truth, but I think a reasonable estimate is between two and a half and 3% for the nominal neutral. But we’ll learn if it’s higher experientially, because as we lower the interest rate, we’ll see economic activity reaccelerate or inflation not go down as fast. And that’s a sign that policy is not quite as tight. I would caution that you can’t do that on a monthly basis, because any – you know, I’ve worked at the Fed for a decade, two decades or more. And what you see in every inflection point in an economy is that the data are volatile, and so you have to smooth through them to try to find the steady underlying pace of growth and rate of inflation. But ultimately, I’m looking for something between two and a half and three. My own estimate is closer to three. I think three is a really good estimate. There’s reasons to believe the neutral rate has risen, but rising all the way up into the fours, it’s not clear that there’s any fundamental reason why that should be.

Nick Timiraos:

So you talk about the data bouncing around, particularly at turning points. Incoming data we’ve had on the economy suggests that output grew at an annualized rate above 3%, maybe in the third quarter. That’s well above the expectation of a lot of private sector economists, Fed officials, who put down forecasts four times a year. When you see this growth coming in at 3% or better, you know, do you say, gee, maybe interest rates aren’t as restrictive as we thought, or is there something else that could explain what’s going on here?

Mary C. Daly:

You know, I would say that that would be more of a hypothesis that’s getting traction if inflation wasn’t falling, but with inflation coming down, then another hypothesis, and I think something that we need to consider, and I’m sure all of you are open to this, being from tech, is that you’re just getting productivity growth. We know labor supply is increasing. If you add to that productivity growth, which we saw increase last year, there’s just a lot of companies out there looking for efficiency gains and abilities to grow output when they know the labor force is limited. So that’s often what a tight labor market does, is it prompts employers to go in and say, what can I invest in that allows me to grow my output and keep the same people, and there’s no shortage of things. And since we’re at a tech conference, what was really remarkable to me is firms always want to do this. But when ChatGPT first came out, it didn’t spur a lot of people figuring how to use generative AI in their business. It spurred a lot of companies to realize they could use regular, ordinary, two-decades-long AI, machine learning and things, and they’re finding ways to do their business better and importantly, to augment the skills of and the people they have already in their shop, not reducing headcount, but expanding output. So that would be consistent with faster GDP growth, good labor force growth, and falling inflation. And we at least have to be open minded to, that’s what’s happening.

Nick Timiraos:

So indeed, one of the pleasant surprises of the last year, and this. I know this data can be noisy, but it suggests that productivity growth or labor efficiency might be improving. How would an increase in productivity growth, if it’s sustained, shape the decisions that you’re making when you decide how to best meet the goals of a strong economy?

Mary C. Daly:

Yeah, that’s a great question. It’s one I think about a long time. So I started at the Fed as a research economist, just got my PhD, end up at the San Francisco Fed doing a research, being a research economist. And one of my early jobs as a research economist, in addition to my research, was to help Chairman Greenspan at the time understand why he saw productivity everywhere around him, but we couldn’t measure it in the statistics. And I don’t know if you remember the late ‘90s. That was a time when the labor market was outstripping anyone’s expectations, when growth was outstripping expectations, and inflation was falling. We just lived through in the pre-pandemic time, a time when the labor market’s expanding, it’s outstripping what people think is possible, and inflation wasn’t rising. This could be a world where, in terms of policy decisions, where we wouldn’t see the labor market outstrip our expectations, or GDP growth outstrip our expectations, and immediately go to, we have to choke it off because it could spur inflation. It would mean that, oh, maybe we can have these things and inflation could stay low. So the impartial judge in all this, just to put a fine point on it, the impartial judge in that debate then is inflation. If inflation goes up, you know that you’ve got a different issue. If inflation continues to go down, then you have to be open-minded. And I think I would want us to be open minded to continue to relax policy. Even when we say a strong economy, I mean, ultimately that’s what we want. I just did a calculation last week. Our expansion right now is relatively young. It’s not even the middle age yet. If you compare it to the previous expansion right before the pandemic or even to the 1990s, you can look way back in history and find long expansions. So we have a young expansion, and we just need to create the conditions. And hopefully inflation cooperates where it can continue to be sustained.

Nick Timiraos:

So if we have a young expansion, that sort of implies it could live for a little bit longer. Does that mean, you know, we’ve heard for the last year, we’ve been writing about the soft landing, which is where inflation comes down without a big increase in unemployment. Before that, we’ve been hearing these predictions of a recession. Have we, I mean, is this the soft landing? Are we living through the soft landing right now?

Mary C. Daly:

You know, I started by saying my definition of a soft landing is something that has more durability. I think it’s – I’ve had the benefit of being at the Fed through two very durable expansions, the 1990s and then the one just preceding the Pandemic. You know, I think that getting that first point, getting to the place where inflation comes down without a big increase in the unemployment rate, that’s an initial condition. And that is what I think economists often call a soft landing. But what people call a soft landing is one that keeps going. Right? Because the descent to this level hasn’t been all that soft. I mean, many, many people struggle with high inflation that kind of chipped away at their wellbeing. And ultimately, my definition of a soft landing is one where we get to 2% inflation and then we end up with a durable expansion, good employment growth, three and a half percent wage growth, and over time, people catch up and continue to build. And that would be good for business, certainly good for households, and, you know, good for society.

Nick Timiraos:

So as you look ahead in this economy you’ve had this, you know, challenging time getting inflation down. As you look ahead, where are the risks now, particularly on the inflation side? In the 1970s, inflation came down, went right back up. When you think about risks to inflation, what keeps you up at night?

Mary C. Daly:

You know, what keeps me up at night is something that I think – I just check it. I mean, I check it almost every day – is that what keeps me up at night is that we have risk to inflation expectations. Now, so far, we haven’t seen any of those move.

Nick Timiraos:

So expectations, meaning what people expect inflation?

Mary C. Daly:

Expect inflation to do. So if you, if you look back before the pandemic, what we were worried about across the globe as central bankers was that inflation couldn’t get up to target. We were fighting it from below our target of 2%, and inflation expectations were inching down. People weren’t as sure that we would reach 2%.Of course, then we got the high inflation, and inflation expectations of the short- and medium-term rather rose rapidly. And so now the good feature is that long-term, medium-term and short-run inflation expectations are now roughly in line with 2% inflation, which means a year ahead. That’s what people expect to see five years ahead and ten years ahead. Those are really good pieces of information. But when I look and they give me some comfort. But as a central banker, you can never get comfortable just checking it once. So I think when I worry about inflation, I worry that we really are shifting from a world where we could reliably fight inflation from below our target. And now we’re in a world where we’re fighting inflation perhaps below or above our target. We have to be prepared for that. It is not the 1970s, though. If you look at the inflation expectations data a cool thing to do if you’re ever interested in a cocktail party conversation for your friends, is to just go and look at what inflation expectations was doing in the seventies. They were not stable.

Nick Timiraos:

I don’t know what kind of cocktail parties you go to.

Mary C. Daly:

Well, that’s a fair point. That’s a fair point.

Nick Timiraos:

You know, I’ll try it.

Mary C. Daly:

I’m embarrassed. The cocktail parties I go to, people are interested in that. They’re also interested in learning what people from tech say. So, I don’t know, Nick, maybe I’m in the wrong business.

Nick Timiraos:

I want to shift gears and ask about banks here. Silicon Valley Bank, whose sudden failure came as a surprise to a lot of people in this audience, was in your turf. Now, I know you’ve said in the past, the responsibility for supervisory shortcomings resides with the Fed Board in Washington. They’re the ones choosing how to supervise and regulate the banks. The Reserve Banks simply provide the boots on the ground. They’re not the generals or the colonels, but a lot of people find that unsatisfying. They’re saying, if you see something, say something. So a three-parter here: Do Reserve Banks have a responsibility to do that? See something, say something? Did the San Francisco Fed miss something here? And what have you done to make sure that this doesn’t happen again?

Mary C. Daly:

Yeah. So let me rephrase a little bit how you started this. So I would never say that the Board’s to blame, and we have no responsibility. What I will say is that statutorily, the Board sets a regulation, the Board of Governors, no Reserve Bank president, sets the supervisory framework and the execution of supervision using teams on the ground. Now, before I go farther, why is that? Why is that something that is important? It’s because one of the strengths of the Federal Reserve, Washington, to have banks do the same things across the country so that you’re not, if you bank in California, you’re not treated differently than if you bank in Kentucky. And so that’s a feature, not a bug. But it doesn’t mean that any of us is collectively responsible or not responsible. So I would say that we are responsible. Each and every person who works at the Federal Reserve System across the country is responsible for looking at what happens when a bank fails, looking what could have been done better, and looking about how we’re going to make the system overall better, even if we don’t have direct responsibility. So I take full responsibility for things, even if I don’t own them. And I think that’s important for us all to do. So did we see something and say something? Of course. Did people, earnest people doing their jobs get it wrong? Absolutely. One of the things that is, another thing I want to remind everybody of, is there are over 4,500 banks in the United States, and three failed. And one of the benefits of the system is that while it was pretty dramatic that Silicon Valley Bank failed in a one-day period, and we learn a lot about the speed of people moving their money and liquidity provisioning. What’s really remarkable is that the rest of the banks, other than three, managed their risks appropriately, did their work, got themselves through a stressful situation, and continued to function and intermediate. So that’s a key lesson, I think. Another lesson I’ve taken – I’ll leave you with these two on this question. The first is, the Federal Reserve as a system, and this, I mean, I can’t speak for other regulators, but it’s true of institutions. We’re good at fighting the last war. So the financial crisis, we did a lot of things. The same issues that crept up in the financial crisis didn’t creep up, but we have to be more forward-looking. What are the things that are risks going forward? And one of the risks that I really see now that we should have been watching as a collective, not just all Feds, and the system in general, is a different kind of concentration risk that we’re used to thinking about. So there’s concentration risk, which if you’re in bank or banking, you know, the concentration risk of only lending to a small group of people with the same – where the same shock could take them all down. So not in the same industries, not having such a small geographic footprint, etc. What was missed, when you look at it exposed, is that there’s a different kind of concentration risk. You could look at Silicon Valley Bank or any other bank – they had different industries, different business lines, different seniorities on how long the businesses had lived, different depositors, but they all were monolined, or concentrated around the network of Silicon Valley and venture capital and startups. When one got nervous, they all got nervous, or a good fraction of them. And I think ultimately, that’s another kind of concentration risk that we have to think about. And ultimately, Nick, this comes back down to the block and tackle of banking, which is you have to understand interest-rate risk and credit risk. Those are the two basics. And Silicon Valley Bank got them wrong at the management level. And we can learn from how to do that better as supervisors and the Federal reserve system.

Nick Timiraos:

We’re almost out of time, but I want to see if there are questions from our audience here. If anybody has a question. I don’t know if we have mics. Yeah, I see a question here, and there’s a mic coming up. If you could identify yourself and ask a quick, pithy question.

Audience Member:

My question has to do with independence of the Fed. Increasingly, in the political arena, there has been challenge around whether the Fed should be independent. What is your view?

Mary C. Daly:

So an independent central bank, and this is true in the United States and across the globe, is a strength of the economies in those sections, it means that the policymaking, what we’re doing right now with the interest rate and ensuring we get price stability and full employment, which Congress gave us those mandates. So we are guided by Congress’s mandates. That independence has been a strength. It means that the policy-making decisions are for the American people and are persistently done with just that in mind, no matter what administration you’re in. So I’m a big supporter of independence. I think historically the evidence shows that it’s an important component of what we do, and we will continue to do our work in the apolitical fashion that we’ve always done it, and achieving the goals that Congress gave us: the payment system, the financial system, and monetary policy with price stability, full employment. And it’s been a winning recipe, and I expect it to continue.

Nick Timiraos:

All right, we have time for one more question, right here.

Audience member:

Very insightful discussion on forward looking indicators. All right, one point I have, because we are, it’s a Tech Live conference, and you mentioned our forward-looking indicators are the key things as you look forward to how you’re applying AI and data, which is critical right to the point you mentioned, or constant risk is changing as well. How are you applying it to look at the forward-looking indicators now?

Mary C. Daly:

So the Federal Reserve has a policy of, we’re not using AI. And so if the question is how are we using AI? We do not use AI as a part of our work in policy or any of the things we’re doing because it’s too new. I mean, I think you’re going to hear this from most businesses. The previous speaker just mentioned that businesses are nervous, and we’re public servants. We’re a public institution. So we’re understanding the technology. In San Francisco, we opened an EmergingTech Economic Research Network, but that’s to understand how others are using it and what it will mean for the economy. And so we’re not using it ourselves to do these types of things. But I’m a trained economist and researcher, and one of the things I see in the economics profession writ large, not in the Fed, is that there’s so many ways you can use it to understand the data, to think about solving problems, asking questions. But I see that in research, in economics, in medicine, etc. So, it’s a developing technology. It’s one I actually am excited about, but I’m in between the evangelists and the doomsayers. I don’t think either of those extremes are the likely ones. I think somewhere in the middle, and it ultimately will depend on us and using it well and wisely is going to have the most durable impact.

Nick Timiraos:

So you’re not running the FOMC statements through AI yet?

Mary C. Daly:

We are not.

Nick Timiraos:

All right.

Mary C. Daly:

We are not. and I don’t recommend it.

Nick Timiraos:

That’s all the time we have. Please join me in thanking Mary for being with us today.